A look at one page of what lies ahead in America’s history

Summary:: This posts shows evidence of the difficult times that lie ahead for America. This makes the November elections of unusual importance. I suspect most of us know this, at some level, even if we collectively refuse to acknowledge it or prepare in any way.

Here are two articles that peer ahead through the fog, looking at the future of one of our larger industries. This is not a case of technological obsolescence, the buggy whip industry being replaced by computer manufacturers — but one facet of a massive social failure now in motion. The list of industries going through the wringer is long and growing: banks, brokers, airlines, automobile manufactures, construction (and the supporting businesses for each of these).

It is too late for prevention — after decades of squandered warnings. All we can do is mitigate the effects and move on.

The slow motion death of the American automobile industry is almost too painful to watch. The flood of bad news coming out of Detroit has literally swelled into a tsunami in recent days, and there is no end in sight.

First came another credit rating downgrade. On July 31, Standard & Poor’s did another number on the industry. In three separate reports, it downgraded General Motors Corp. and GMAC LLC, Ford Motor Co. and Ford Motor Credit Co., and Chrysler LLC and DaimlerChrysler Financial Services Americas LLC (DCFS). The stated rationale for these downgrades (S&P could have chosen a dozen reasons) was basically concern over shrinking cash flows and liquidity at all three companies and their finance arms. While S&P can hardly be blamed for stating the obvious, the rating agency probably didn’t go far enough in continuing to rate the automakers ‘B-,’ one notch above the once infamous CCC+ level. In today’s world, of course, a CCC+ rating no longer bears the stigma that it once did, but in the case of these companies, it is only a matter of time before they bear the insignia of insolvency that such a rating portends.

The world is witnessing a classic case of an industry in denial. Rather than taking the truly radical steps necessary to address its problems, Big Auto’s management is still engaging in incremental change in the hope that it can buy itself enough time to effect a changeover to more fuel efficient models. Unfortunately, these executives are doing nobody any favors by delaying the inevitable balance sheet restructurings that are going to be a necessary component of the endgame for their industry.

Just prior to S&P’s move came the effective collapse of the automobile leasing industry. In the days prior to the S&P downgrade, the automobile financing industry came totally unglued. This is the latest indication of how severely credit is being rationed at all levels of the U.S. economy. Chrysler Finance was the first of the Big Three automakers’ finance arms to announce that it would stop extending automobile leases. This decision, which is nothing less than catastrophic for Chrysler’s vehicle sales despite unconvincing protests to the contrary by the privately-owned carmaker, was due to the fact that leasing has been rendered unprofitable by Chrysler Finance’s rising borrowing costs and the plunging residual value of Chrysler’s gasguzzling vehicles. Chrysler debt is trading at levels that suggest an imminent bankruptcy filing.

GMAC and Ford Motor Credit are not expected to eliminate leasing entirely but are likely to severely cut back on auto leases since they can’t make any money on these transactions. Wells Fargo has also withdrawn from the business of financing car leases. Other financial institutions are sure to follow.

The dramatic reduction in the availability of auto financing will be another nail in the coffin of the American automobile industry (at some point the coffin will have so many nails in it that it won’t need any wood). Leases account for roughly 26 percent of annual auto sales. Just as subprime mortgage financing led many consumers into homes that they couldn’t afford, low-cost auto leases allowed many people to lease cars to which they otherwise wouldn’t have had access. Leases also led many consumers to replace their vehicles in a much shorter period of time than they ordinarily would have done, leading to higher auto sales. Automobile manufacturing and financing is a significant component of the American economy, and we are watching it being deconstructed piece-by-piece before our very eyes. The economy is seeing the dark side of what happens when financial engineering creates false demand for consumer goods that is unsustainable on a fundamental basis.

Finally, on the last day of July and first day of August, GMAC and GM issued two lack-of- earnings releases that not even the happy faces on financial television could spin in a positive way. On July 31, GMAC released its second quarter 2008 results, a loss of $2.5 billion (that would have been much worse without $1.55 billion of lease support payments that GM is obligated to make to GMAC under risk-sharing and support agreements dating from 2006.) GM reported that it has $30 billion in North American leases, including $12 billion in SUVs and $6 billion in other trucks. If current trends hold, GMAC is looking at further multibillion writedowns on these vehicles. Residential Capital LLC contributed $1.9 billion of losses to GMAC during the quarter compared with a $254 million loss a year earlier. HCM will leave it to others to try to find a silver lining at GMAC. The hard truth is that the deterioration of every aspect of this company is accelerating.

Not to be left out in the cold, on August 1, GM announced a grotesque $15.5 billion loss for the second quarter of 2008 ($27.33/share on an $11.00 stock price for those who are still counting such things). Global sales plunged by 18 percent during the quarter, with U.S. sales fading by 16 percent through June. July trends continue to point sharply downward, and the effective elimination of leasing by GMAC can only further reduce sales. A significant portion of the loss was attributable to charges for attrition programs (i.e. job reductions), an adjustment to its reserve for its former parts-maker Delphi Corp., and a $2 billion loss attributable to lower residual values for leased vehicles. But at this point, HCM would seriously discount the one-time nature of these charges, which continue to hit GM’s balance sheet with depressing regularity as the company continues to try to dig out from the detritus of its past business structure and history. Backing out these so-called one-time charges left GM with a $6.6 billion quarterly loss, which was still 450 percent larger than analysts projected (which is further evidence that nobody, and HCM means NOBODY, has a clue about how GM is going to survive as a going concern).

The latest news out of Detroit makes it abundantly clear that the endgame for the Big Three is going to be massive bankruptcy restructurings. One would hope that politicians in Washington, particularly the two Presidential candidates, would begin formulating national energy plans that include restructuring plans for the American automobile industry. No viable energy plan will meet this country’s needs without creating the proper tax and other economic incentives to build fuel-efficient vehicles. Rather than continuing to be one of the problems that lie at the heart of the American economy, the recovery and revitalization of the auto industry could be a major component of an economic and energy policy that could lead this country out of the difficult times we are experiencing and are doomed to repeat unless we take some bold steps right now.

9 thoughts on “A look at one page of what lies ahead in America’s history”

I hope the American taxpayers are not called on to pay the costs of the auto industry failure. The problems are decades old. Directions to solutions are equally old. The Big 3 believed only they knew how to build cars. The world has known for a long time that is not true. It’s time they took their well-deserved lumps. There are enough decent auto companies in the world to take up the slack. In fact, the industry as a whole will be more healthy with some of the excess capacity stripped out of the system.

American workers should be helped to retool. They have not been the problem. Management has been, and continues to be, the problem.
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.Fabius Maximus replies: (1) Of course they will. Unemployment insurance and welfare benfits for the workers. The Pension Benefit Guarantee Corp (PBGC) will take over the pensions, probably neding government money. And so forth.

(2) This overlooks the point of my post (which I have tweaked to make more clear: it is not just one industry. The coming downturn will severely damage many key American industries. Hence this is a systemic event. What is happening to autos is just a symptom, not the illness.

Helping the auto companies re-structure toward building fuel-efficient cars is only one aspect of a possible national program of public investment in alternate energy — first proposed a few years ago by a group called the “Apollo Alliance”. I think they still have a website. Such a program is an inevitable first step, but it is very possible to be highjacked (exploited to their private advantage) by the same interests that got us here (energy, transportation, home-building, etc). Once they add their historic profit requirements to any new technology it is apt to be just as costly in social, financial and environmental terms as our current oil-based ones. The mania for corn-based ethanol is a good example. One of the brighter ideas of the Apollo Alliance thinkers was to direct a large share of new development funds toward existing military providers, as an incentive to shift from military to civilian production.

Beyond simply new technologies, the problems we face require radical new approaches to social organization, as in sustainable community development, local power aggregation, shift of political decision-making to local levels, etc.

The late John DeLorean, a highly successful executive at General Motors, wrote “On a Clear Day You Can See General Motors,” which one Amazon reviewer (J. Reynolds) wrote was an “examination of the stagnation of General Motors, which beginning in the mid-1970s declined into a top-heavy bureaucracy that appeared to have forgotten it was in the automobile business.” Another reviewer, J. Gresham, wrote: “A fault that GM has had for a long time is its feeling that, since it sells more cars and trucks than anyone else in the world and makes far more money than any other automotive company, the GM way is the only way.” And that was thirty years ago.

Well, GM doesn’t sell more vehicles than anyone else in the world any longer, Toyota does.

Regarding “systemic event,” and “many key American industries,” it is worse than that. The profit-driven, inefficient, uncaring top-down corporate model, as plato’s cave suggests, has been wrongly extended nationally, with an overbearing national government autocratically led by an “executive-privileged” president who makes lousy decisions from which we all suffer. (Current presidential candidates, the new “deciders,” are now being plumbed for what THEIR decisions will be on important matters.) So much for democracy, but on a clear day you might see the United States.

“The coming downturn will severely damage many key American industries. Hence this is a systemic event.”

Is it a coincidence that these events are taking place at a time when the “ecological” setup of traditional US industries is so concentrated and so lacking in diversity that the demise of a couple of firms basically means an entire sector is wiped out?

Not long ago the big 3 automobile manufacturers were actually 4 (with AMC), and there were 3 large civil aircraft manufacturers, not just one. And a bit farther back they were 5 and 4 respectively.

THERE IS rumor that Iran has purchased this technology from one of the former USSR COUNTRIES.

ALSO CHECK THIS CLIP FROM DISCOVERY CHANNEL.
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.Fabius Maximus replies: I do not understand why this is worse than just nuking us? In fact, I am sure this is not as bad as nuking cities. As I understand this, EMP’s were a tool for complex WWIII scenarios. Not a likely game for Iran play anytime soon (if ever). Nor will EMP textbooks do Iran any good until they develop nukes (which I assume they will eventually do).

I also find difficult to understand your certainty that an EMP attack will happen to America in the foreseeable future. For my entire life, which overlaps the entire cold war, I have lived in the shadow of confident predictions that nuke wars were inevitable very soon. Not so far.

Nor do I consider the crazy “Iran theory” any more likely than the “crazy Ivan” theory. The latter was without any empirical support, as is the former today.

Umair Haque has been making the same post about the decaying strategy of 20th century businesses model. While he takes it into a economic context and you take it into a political context both you share the same concern, decaying DNA that is harming America.

Unfortunately, we will probably be bailing out these companies, since we base this opinion on the precedent of the companies that have received government help before them. While you see it as a symptom, not the illness. I concede such a point. The point I would present is the death of these companies leaves a vacuum for such companies that create value and have sustainability to sweep into the market.

Gut feel is that Chrysler will go soon and either GM or Ford in a year or two, with the survivor resonably prospering. Whoever has the most cash will survive, though both of their ‘cash burns’ is frightening to consider. Basically they can last another 1-2 years, at most, until they run out of money. Other companies will cherry pick the profitable components, so some bits of Ford or GM crash will survive. The one I really don’t understand is Ford, it has a very sucessful range of excellent cars and engines made in Europe. Why they have been so tardy in introducing them to the US is beyond me.

As for the US Govt bailing them out, how? Bernanke and Poulson have shot all their bolts on ‘saving’ the financial system. Just the ‘Freddy/Frannie’ effective nationalisations will mean the US Govt (ie the taxpayers) will have to pump ‘hundreds’ of billions to re-capitalise them. The US Govt is up to its eyeballs in debt already and at a stroke of a pen its debts and liabilities have increased massively. So I can’t see where the money for a Ford and/or GM bailout is going to come from, since they are still having to pump squillions everyday into the rest of the financial system to keep it (sort of) afloat.
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.Fabius Maxmis replies: As I note above, the problem is not the auto companies. It is a systemic problem, of which the problems of the auto industry are just individual examples.

It is amazing to me that GMAC is continueing to be artifically resporated by GM and Ceberus. What value proposition does GMAC bring to either company other than to expand their losses. Bankrupt it or sell it off before it brings down the whole ship. If the GM and Ceberus executives dont I believe the Utah State Banking Authorities will.